Part 17 · Chapter 3

Payroll Taxation and W-2 Reporting of Benefits

Law stated as of October 3, 2026 · Fringe Benefits and Employment Taxation

Scope and status

This chapter covers the employment-tax and Form W-2 mechanics for the benefits addressed elsewhere in this Part: disability and sick pay, life insurance and AD&D proceeds, severance, and the statutory fringe benefits under §§132, 127, 137, and 79. It also covers third-party sick pay reporting (Form 8922) and the current status of the fixed-indemnity/voluntary-benefit taxation proposed regulations. Related questions are treated elsewhere: the underlying tax-exclusion mechanics for §§132/127/137/79/128 in Statutory Fringe Benefits: §§132, 127, 137, 79, and 128; the ERISA plan-status analysis in ERISA Plan Status of Fringe and Welfare-Adjacent Arrangements; and §125 cafeteria plan pre-tax election mechanics in Part 13's §125 chapter.

Sections

Part A is shown in full. The other sections are listed by title; their text is available to subscribers.

Part A — Disability and Sick Pay Taxation

A1.The premium-source rule

Part 17, ch. 3, § A1

Disability benefits are taxable to the recipient in the same proportion the premium was paid with employer dollars not previously taxed to the employee; benefits are excludable to the extent the premium was paid by the employee with after-tax dollars. Statute: Code §§104(a)(3), 105(a); Final reg: Treas. Reg. §1.105-1. Where the employer pays a group disability premium without including its value in the employee's income (the ordinary case under §106(a)), 100% of any benefit paid is taxable as ordinary income when received. Statute: Code §§105(a), 106(a). Where the employee pays the entire premium with after-tax dollars (no employer contribution, and — critically — not paid through a §125 cafeteria plan on a pre-tax basis), benefits received are fully excludable under §104(a)(3). Statute: Code §104(a)(3). Where the employer and employee split the premium of a group insured policy, the taxable portion is the employer's share of the net premiums for the last three policy years known at the beginning of the calendar year (fewer if the policy is newer); for an individual policy, the current policy year's ratio is used. Final reg: Treas. Reg. §1.105-1(d). A different rule applies where each employee irrevocably elects, before the plan year, whether employer-paid premiums are taxed to the employee (after-tax) or not: the election in effect for the plan year in which the employee becomes disabled controls, and the three-year rule does not apply. Rev. Rul.: Rev. Rul. 2004-55.

A2.Employee elections — the annual opportunity

Part 17, ch. 3, § A2

Because the taxability of a future disability benefit turns on how the current premium is paid, many LTD carriers and employers offer employees an annual, irrevocable choice to pay the LTD premium with after-tax payroll dollars specifically to preserve a tax-free benefit if disability occurs. Rev. Rul.: Rev. Rul. 2004-55.

A3.Third-party sick pay and the six-month FICA rule

Part 17, ch. 3, § A3

Whether the employer or a third party (an insurer or a separately funded trust) pays disability/sick pay, FICA continues to apply for the first six calendar months after the last calendar month in which the employee worked; sick pay paid after that period is excluded from FICA wages. The portion of any payment attributable to employee after-tax contributions is never FICA or FUTA wages, even inside the six months. Agency guidance — formal: IRS Pub. 15-A. Statute: Code §3121(a)(4); Final reg: Treas. Reg. §31.3121(a)(4)-1. "Sick pay" for this purpose does not include disability retirement payments or payments that are strictly for medical or hospitalization expenses. Final reg: Treas. Reg. §31.3121(a)(2)-1.

A4.Third-party sick pay reporting: the split obligation and Form 8922

Part 17, ch. 3, § A4

When a third party pays sick pay includible as wages, either the third party or the employer reports it on Form W-2 depending on the parties' agreement, and — because Forms 941 and W-2 reporting responsibilities can be split between the employer and the third-party payor — the IRS requires an annual reconciliation filing, Form 8922 (Third-Party Sick Pay Recap) when the employer's share of FICA is reported on the employer's return but the W-2 is issued under the other party's name and EIN (the party that did not issue the W-2 files), due by the last day of February following the year the sick pay was paid (next business day if that falls on a weekend or holiday). Agency guidance — formal: Notice 2015-6; IRS Instructions for Form 8922. An employer filer must file a separate Form 8922 for each contract with a third-party payor; an insurer or agent filer may aggregate unless it chooses to identify each employer. Agency guidance — formal: IRS Instructions for Form 8922.

Part B — Life Insurance and AD&D Taxation

B1Death-benefit proceeds are generally tax-freeSubscribers
B2The transfer-for-value trapSubscribers
B3Employer-owned life insurance (COLI/BOLI)Subscribers
B4Employment tax treatmentSubscribers

Part C — Severance Pay Employment Taxation (orientation only; detail routed out)

C1Severance is FICA/FUTA wagesSubscribers
C2Income-tax withholding and reportingSubscribers
C3The §409A overlay does not change the FICA answerSubscribers

Part D — Form W-2 Box 12 Codes for Fringe and Welfare Benefits

D1The codes that matter for fringe and welfare benefitsSubscribers
D2What has no dedicated box 12 codeSubscribers
D3§128 Trump Account employer contributionsSubscribers
D4Tips and overtime (new for 2026)Subscribers

Part E — Voluntary Benefits Paid Through a Cafeteria Plan: The Live Currency Item

E1The general rule and the 2023 proposal that was not finalizedSubscribers
E2What actually happened: the taxation piece was not finalizedSubscribers
E3The 2024 notice requirement — finalized, then vacatedSubscribers

The first Part of each chapter is open to everyone. The remaining sections, with their authority and practice points, are available to subscribers and to clients of ERISA Benefits Law Group, PLLC whose engagement includes access.